October 15, 2012

Money Market Funds Analyzed

A recent New York Federal Reserve Bank staff report outlines a proposal for strengthening money market funds. According to a blog post by N.Y. FRBank Senior Financial Economist Marco Cipriani, Officer Michael Holscher, Assistant Vice President Antoine Martin and Senior Economist Patrick McCabe, the intent of the proposal is “to reduce, and possibly eliminate, the incentive for investors to run from a troubled fund, while retaining the defining features of money market funds that make them popular financial products.” According to the authors, the proposal is similar to one requested in a letter Treasury Secretary Tim Geithner recently sent to the Financial Stability Oversight Council.

Among other things, the N.Y. FRBank proposal would allow money market funds to maintain a stable $1 net asset value and to provide investors with liquidity on demand; however, a small fraction of an investor’s balance—minimum balance at risk—would be available for redemption only with a delay. The proposal would require the minimum balance at risk to be large enough, and the delay long enough, to ensure that redeeming investors share any costs of their redemptions and any imminent portfolio losses with nonredeeming investors, according to the post.

The authors stress that, with a minimum balance at risk in place, redeeming investors would not be able “to eliminate their entire money market fund exposure immediately; as a result, the incentive to run

would be reduced.”

The authors state that money market funds present a policy challenge. They state that, although “they are important intermediaries for short-term funding and popular cash-management vehicles for retail and institutional investors, the funds are vulnerable to runs that can harm investors and the financial system.” They assert that the adoption of a minimum balance at risk rule could “significantly reduce the risks that money market funds pose during crises while preserving their important role in the financial markets.”